Emerging from bankruptcy, Bally Total Fitness wanted new leadership to implement a new business strategy. Not surprisingly, it looked for someone who knew the workout business. The company found Michael Sheehan, COO of its chief competitor, 24 Hour Fitness.
But what might have seemed like the ideal fitness company fit is now stuck on the litigation treadmill. 24 Hour Fitness filed suit in July in the U.S. District Court for the Northern District of Illinois, alleging that Bally Total Fitness lured Sheehan away to obtain company trade secrets. 24 Hour Fitness also claims that its contract with Sheehan included a noncompete clause preventing him from joining a competitor for two years after he left the company.
As a CEO of Bally, “Sheehan cannot ‘unring the bell,’ as he will be charged with executive responsibilities for the same areas that he worked in as [chief operating officer] of 24 Hour Fitness,” the company said in its lawsuit.
Similar battles are being waged in courts across the country with more frequency than ever before. Some experts estimate that state and federal courts make 120 decisions per month related to noncompete agreements and trade secrets.
“Business poaching is on the rise, and companies–from general sales and financial services to distribution and information technology–need to be on the offensive,” says David Walton, a member at Cozen O’Connor.
A confluence of factors is fueling the surge in executive raids and ensuing litigation.
“There are two major reasons we hear more about these cases today than we did 10 or 15 years ago–mobility and technological advancements,” says Michael Greco, a partner at Fisher & Phillips. “If you talked to people 20 years ago, it was more common for them to have spent a substantial part of their career with one employer. Today’s generation tends to move around to several employers.”
And new technology such as flash drives, experts say, allows information to walk out the door when employees do, forcing employers to seek new ways to trace the culprits.
The state of the economy also plays a significant role in the breach of noncompetes or confidentiality clauses.
“We’ve noticed an increase in these cases when the economy is on the move, either on the way up or the way down,” Greco says. “When the economy is on the way up, companies have money to throw at new employees, and employees believe that the grass is greener on the other side.”
When the economy goes south, he says, some companies “feel the need to protect their turf” from companies struggling to recover from a financial setback. 24 Hour Fitness, for example, alleges that Bally targeted Sheehan to become CEO as part of a new business strategy when it emerged from bankruptcy.
Going on the offense, however, can be a complicated matter in the absence of federal law governing noncompete agreements and trade secrets. Individual states are left to adopt statutes that are far from uniform. The California Supreme Court, for example, recently ruled in Edwards v. Arthur Andersen that California employers cannot enforce agreements limiting competition by former employees, except within very narrow statutory exceptions.
“[The California ruling] will cause in-house counsel to go back and review their covenants or agreements to make sure they are compliant with state statutes,” says Douglas Farmer, managing shareholder at Ogletree Deakins.
According to Greco, California and North Dakota are the only two states that generally outlaw noncompetes.
“You can divide the country into two groups,” he says, “states where noncompetes are outlawed, with a few exceptions, and states where the courts will modify overly broad restrictive covenants. For example, if a covenant says that after an employee leaves he won’t compete within 50 miles for two years, a judge might modify that to one year and 30 miles.”
Walton thinks more states will follow the California pattern going forward, albeit with caveats.
“We’re going to see more states reacting negatively toward noncompete agreements, but at the same time giving employers greater latitude to protect their trade-secret claims,” he says. “So states will say to employees, ‘You can leave, you can go to the competition, but you’d better not take anything with you.’”
Whatever the laws, experts agree that employers should assume that some employees will steal information and take it to the competition.
“You need to know what your secrets are and take steps to keep them secret,” Greco says. “When you get down to it, what is it that truly meets the definition of a trade secret? It’s information that’s not readily available from proper means to your competitor and is valuable.”
He suggests limiting access to the information to employees who have a need to know, making sure the information is password protected, banning flash drives from the office and having employees sign appropriately tailored and enforceable restrictive covenants.
“If you write a covenant that says, ‘You’re not going to compete with us within 1,000 miles for five years,’ you’re going to have trouble,” Greco says.
Walton adds that the smartest thing an employer can do when an employee takes a job with a competitor is freeze everything on the employee’s computer and on the server.
“Then get a third party, a forensic expert, involved to start collecting evidence,” he says. “That way you can preserve the chain of custody and build a better argument.”
What should an employer do if wrongfully accused of recruiting someone to steal another company’s secrets?
“Ask yourself those questions before you get hit with a lawsuit, when you’re in the recruiting process,” Greco says. “Ask the prospective recruit for a copy of any contract he may have signed with the current employer. Review that agreement to determine whether it’s reasonable and enforceable and whether there’s a capacity in which you could employ that person that complies with the terms of his contract.”
Just as important, he says, is to tell a new employee not to bring anything with him when he comes.
Even that, of course, won’t prevent a new employee from crossing the road with confidential and potentially compromising information. If he does, “keep that information out of your system,” Walton says. “Treat it like receiving stolen property. Tell the other side. A cover-up is worse than the crime.”